Income-Expenditure Model

• Ahm97sic

  30 Aug 09, 15:13

  For H3 Economics students to practise

  1.  Income-Expenditure Model ie Simple Keynesian Cross Model (2 sectors case)

       C = C(Y - T) = a + bYd                 where a > 0 and 0 < b < 1

                                                          a = autonomous consumption

                                                          b = marginal propensity to consume

                                                        Yd = Disposable Income

      I = Io                                           where Io = exogeneous investment

      M/P = L(r,Y)                                 where Lr < 0, Ly > 0

      P = Pf                                          where Pf = Fixed Price Level

      What would be the equilibrium for the keynesian cross model look like in a

      standard IS-LM diagram ?

   

   

   

   

• Ahm97sic

  26 Sep 09, 21:55

  Solution

  (a)   Since the IS equation is not a function of interest rate, so IS curve will be

         a vertical line.

  (b)    M/P = L(r,Y) 

          Since the price level is fixed and money supply is fixed,

          0 = Lr dr + Ly dy

          dr = ( - Ly dy) / (Lr)

          dr/dy = - Ly / Lr

          Since Ly is +ve , Lr is -ve

          overall dr/dy = +ve

          Hence, LM is an upward-sloping curve

  Conclusion : For the keynesian cross model, IS will be a vertical line and

                     LM is an upward-sloping curve.

  Thank you for your kind attention.

  Regards

  ahm97sic